Select Committee on Treasury Third Report

4 Other Issues

The housing market

56. At the time of the assessment of the five tests on entry into the euro, the Chancellor stated that "most stop-go problems that Britain has suffered in the last fifty years… have been led or influenced by the housing market. The volatility of the housing market and potential for higher inflation is a problem for stability that we are determined to do more to address to produce greater stability and reduce the risks of inflation irrespective of the decision on the euro."[158] Two reviews were announced: by Professor David Miles into the supply and demand factors limiting the development of fixed-rate mortgages in the UK and by Ms Kate Barker into the issues affecting housing supply in the UK. Both these reviews produced interim reports published at the time of the PBR,[159] with final reports with policy recommendations to follow at the time of the Budget. The CBI welcomed the Barker review which "recognises the problem of housing supply and the part played in that by planning restrictions and hope that appropriate policy action will result"; however they hoped that neither of the reviews aimed at housing would "result in any new tax on the property sector, nor in any unnecessary regulatory intervention in the markets".[160] In regard to the Barker review Mr Weale told us that "The main mechanism for improving the housing situation is to ensure that more houses are built. Without having more houses being built, if you simply make it easier for people to invest in housing through the introduction of real estate investment trusts, then one might think that that will add to rather than reduce upward pressure on house prices."[161]

57. The Chancellor would not "draw conclusions" on how long it would take for a substantial move to fixed-rate mortgages and before any reforms from these two reviews produced a detectable difference in terms of smoothing the operation of the macroeconomy, but told us that the Treasury had asked "Ms Barker and Professor Miles to look at these issues and report to us".[162] The Committee believes that improving the functioning of the UK housing market has a key role, not only in terms of stability and growth in the UK economy, but also in tackling social inequalities by improving the access of families and others to decent housing at an affordable price. We also note the important role of the housing market in promoting labour mobility and regenerating deprived areas. We welcome the interim reports of the Miles review of fixed-rate mortgages and the Barker review of housing supply. Alongside any policy recommendations their final reports should also estimate how long it would take for any shift to fixed-rate mortgage finance in the UK, and improvements in housing supply, to produce a detectable difference in terms of smoothing the operation of the macro economy. We may examine the detail of any recommendations made as part of our regular scrutiny of the Budget.

58. After reaching a peak in the first quarter of 2003, house price inflation then moderated. For 2003 overall, annual house price inflation on the Nationwide index was 15.6%. There has been a divergence in performance between regions with house price growth in London in single digits but with growth rates of 30.1% for the North and 27.3% for Yorkshire and Humberside. The RICS recently estimated that the ratio of house prices to average income was 6.1 in the third quarter of 2003.[163] There may be structural reasons why a permanent rise in house prices relative to incomes is justified. Mr Cunliffe told us that "The amount of their income people are paying in mortgage payments or interest payments generally are low compared with the rates we saw at other times in the housing market house of high price increases in the late 1980s, early 1990s. If you look at the affordability, it is not clear to me that we are actually in a position where there will be a sharp break in confidence." As the Bank of England Governor has noted, loan to value ratios have not risen by as much as in the late 1980s.[164] Indeed, in the third quarter of 2003 only 22% of loans were for more than 90% of the property's value, compared with figures of over 40% in the late 1980s and early 1990s. However, the proportion of new borrowers with loan to income ratios in excess of three and a half has risen substantially in recent years,[165] but due to low interest rates the initial burden of the debt is much reduced (although the low inflationary environment will mean that debts will not be eroded as quickly). It is borrowers that have a large mortgage to income ratio who are exposed most to unexpected rises in interest rates and could benefit most from a fixed mortgage payment. However, as they are likely to be spending a higher than average proportion of income on their mortgage in order to purchase a house, they will be most interested in the initial costs and, as Professor Miles identified, "variable rate products and short-term (two-year) fixed-rate mortgages look very much cheaper than longer-term fixed rate products".[166] Using the prices given in the Miles review, for a borrower with an advance of 5 times income the cost of a discounted variable rate will be around 39.9% of net income, compared with around 47% of net income for a 5-year fix.[167]

59. The document accompanying the budget "Simplifying the taxation of pensions" included proposals to "allow pension schemes to invest in all types of investments including residential property".[168] Mr McPhail of Hargreaves Lansdown was quoted as saying that "It is hard to reconcile the stated ambition of controlling the housing market's disproportionate influence on the economy with a proposal that will allow billions of pounds of pension fund money to wash into the housing market".[169] There has been some comment in the press as to the extent to which individuals may be able use their pension fund to purchase single houses, or even to transfer in second houses and holiday lets, rather than invest through any new form of Real Estate Investment Trust. The Chancellor told us that the proportion of houses in "the private rented sector is very low…far lower than in Germany, France or America" and that Shelter had issued a report saying that it was "necessary to get more incentives into the private rented market so that we can have more private rented housing available and we are looking at how it can be done". He added that the Treasury had not committed itself "either to billions of pounds of incentives or to expecting there will be billions of pounds of property investment by pension fund companies".[170] The Treasury should assess the extent to which allowing self- administered pension funds to invest in residential property by buying individual houses, rather than via any new type of Real Estate Investment Trust, will increase the sensitivity of the economy to the housing market and create opportunities for abuse. If the proposals are implemented the Inland Revenue should ensure that a robust regime is in place to prevent tax avoidance.

Taxation of small incorporated businesses

60. The Pre-Budget report notes a range of measures and targeted tax reductions to support small businesses. Edward Troup, Head of Tax Strategy at Simmons & Simmons told us that "The introduction of a 10% corporation tax rate in 2000 (reduced in 2002 to 0% on the first £10,000 of corporate profits and 10% on the next £40,000) has encouraged large numbers (probably several hundred thousands) of the self-employed to incorporate their businesses. This permits a significant saving of income tax and NICs as self-employed earnings (taxed at basic rate of 22% plus NICs of 11%) can be converted into dividends (subject to corporation tax at 10% or 0%) which are not subject to further income tax in the hands of basic rate taxpayers".[171] Mr Chote told us that "the move to zero corporation tax rate does seem to have turned out to be very costly for the government in the sense of encouraging people who are self employed to incorporate themselves. That was something which was predictable, and plenty of people predicted that it would turn out to be a very expensive policy."[172]

61. The PBR indicates that "The Government is concerned that the longstanding differences in tax treatment between earned income and dividend income should not distort business strategies" and that it "will therefore bring forward specific proposals for action in Budget 2004, to ensure that the right amount of tax is paid by owner managers of small incorporated businesses on the profits extracted from their company".[173] John Whiting of PricewaterhouseCoopers noted that this development "has caused a deal of concern to such businesses and their advisers" and added that "surely it would have been possible to give a more detailed explanation of what is envisaged".[174] Mr Troup noted that "If the reduced and zero rates are not achieving their intended result, the Government should not adopt a complex retaliatory response, but should repeal these measures and if appropriate, offer tax reductions to all small businesses (incorporated or self-employed) in some alternative way".[175] We would welcome further details (in advance of the Budget) of the nature of the Government's proposals for changes to the way tax is paid by owner managers of small incorporated businesses on the profits extracted from their company.

Child poverty and the Child Tax Credit

62. The 2000 Spending Review included a target to "Make substantial progress towards eradicating child poverty by reducing the number of children in poverty by at least a quarter by 2004".[176] The Pre-Budget Report announced that the 'child element' of the Child Tax Credit "will increase from April 2004 by £180 to £1,625 a year, equivalent to a weekly increase of £3.50".[177] This measure will increase support to families with children by almost £1 billion each year.[178] The IFS has previously noted that "for a given level of expenditure, increasing the per-child element of the child tax credit will have a larger direct impact on poverty than increasing the family element or increasing child benefit".[179] Mr Chote told us that it was "quite possible that the Chancellor is going to hit the [child] poverty target on the basis of this increase";[180] he added that there was some concern that "having a target that is so clearly fixed as a target of relative income" could create "an excessive bias towards trying to deal with child poverty through direct cash transfers, when it might well be more appropriate to take some money and devote it to services like…Sure Start". The Chancellor told us that "by raising the 'per child' element we were able to do more about the position of lower and middle income families" and that, by 2004, "Before housing costs there is absolutely no doubt in our view that we [will] meet the 25 per cent cut in [child] poverty since we set the target"[181]. The Chancellor also noted that in addition to the increased tax credit the Budget had announced "a new scheme to help lone parents get into work".[182] We welcome the Government's action to reduce child poverty and note the substantial progress made so far. The approach needs to establish an effective balance between providing income to the parents through the tax credit system with expenditure on services aimed at increasing opportunity for both the parent and the child.


63. The savings ratio for the United Kingdom is low, particularly for people on low incomes, and hence Government policy has been to encourage people to save. In that context cash ISAs have proved popular with low income earners, as the Nationwide Building Society and Halifax Bank of Scotland testify. To reduce cash ISAs from £3000 to £1000 per year, and share ISAs from £7000 to £5000, appears to run counter to a policy of encouraging people to save. We, therefore, request an explanation for this apparent contradiction in policy and recommend that the proposed ISA reductions should be reconsidered.

158   HC Deb , 9 June 2003, col 411 Back

159   Review of Housing Supply, Kate Barker, HM Treasury December 2003; the UK Mortgage Market: Taking a Longer-Term View, David Miles, HM Treasury December 2003 Back

160   Ev 58 para 9 Back

161   Q 79 Back

162   Qq 392-383 Back

163   RICS press release, House prices to rise 6% in 2004, 23 December 2003 Back

164   Bank of England, Inflation Report Press Conference, 12 November 2003 Back

165   Council of Mortgage Lenders Back

166   The UK Mortgage Market: Taking a Longer-Term View, David Miles, HM Treasury December 2003, p 2 Back

167   The UK Mortgage Market: Taking a Longer-Term View, David Miles, HM Treasury December 2003, Table 4.3, p 56 Back

168   HM Treasury, Simplifying the taxation of pensions: the Government's proposals, 10December 2003 Back

169   Financial Times, Investing freedom for funds, December 13 2003 Back

170   Q 381 Back

171   Ev 72 Back

172   Q 68 Back

173   Pre-Budget Report 2003, para 5.91, p 117 Back

174   Ev 76 Back

175   Ev 72 Back

176   HM Treasury PSA target 8 (joint target with Department for Work and Pensions) Back

177   Pre-Budget Report 2003, para 5.19, p 98 Back

178   The actual costs given in the PBR Table B4 are £885 million in 2004-05, 925 million in 2005-06 and £955 million in 2006-07 Back

179   What do child poverty targets mean for the child tax credit? An update, Mike Brewer, IFS, December 2003 Back

180   Q 87 Back

181   Qq 341-342 Back

182   Q 374 Back

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